Editor’s Note: Today on Health Affairs Blog, Courtney Burke and Erika Martin of the Nelson A. Rockefeller Institute of Government/Rockefeller College of Public Affairs & Policy at the State University of New York in Albany examine two related issues that will be important to monitor and address as health reform is implemented. Below, the two researchers discuss the impact of phasing out Medicaid Disproportionate Share Hospital payments. In a separate post, they discuss access to care for undocumented immigrants and the costs of such care.

Recently enacted federal health reforms are designed to increase access to health care by making insurance more affordable and accessible. At the same time, federal payments to states to cover the cost of uncompensated care for uninsured or low-income populations through the Medicaid Disproportionate Share Hospital (DSH) program will be phased out.

In theory, if health reform works, more individuals will be covered and there will be fewer uncompensated care costs, reducing the need for Medicaid DSH. In reality, it is difficult to predict the effects of eliminating DSH payments because Medicaid DSH funding streams are not transparent. Few people know how these funds are distributed, exactly what they are used for, who and how many people get health services because of DSH, and how the funds flow to health providers.

Given their primary purpose, the distribution of federal Medicaid DSH payments should closely mirror the rate of uninsured in each state. This is not the case. In 2005, Florida received $52 in Medicaid DSH payments per uninsured person, whereas New Hampshire received $1,214 per uninsured person, according to data on DSH allotments from the Kaiser Family Foundation and data on uninsured rates from the United States Census Bureau.

Why is Medicaid DSH funding so different across states? There are several reasons:

States have used DSH funds for very different purposes. Some states have targeted these funds to specific types of facilities such as psychiatric hospitals, with particularly hard-to-serve populations and few private payment sources to cover uncompensated costs, while other states have used across-the-board formulas to distribute funds to all hospitals based on the proportion of low-income persons they serve.

DSH doesn’t just cover the cost of care for those who are unable to pay. It also fills the gap between the cost of care and what providers are paid by Medicaid to deliver that care. Public hospitals, which tend to serve a larger percent of persons on public health insurance (up to 70 percent of their patients), are particularly reliant on DSH funds because Medicaid pays providers at a lower rate than private insurers do.

The federal government has treated states differently in regulating DSH. Massachusetts, for instance, was at risk of losing several million dollars in federal DSH funding if it didn’t decrease the number of its uninsured residents. (It consequently enacted health reform legislation.) Meanwhile, other states were not required to do the same.

Reform’s Challenge

State Medicaid DSH payments are anticipated to be reduced quarterly starting in 2014. From 2014 to 2020, the estimated total loss of Medicaid DSH funds to states will be $18.1 billion; not a small figure for states that are currently facing fiscal challenges. (The aggregate reductions are: $500 million in FY 2014, $600 million for FY 2015 and 2016, $1.8 billion for FY 2017, $5 billion for FY 2018, $5.6 billion for 2019, and $4 billion for FY 2020. The secretary of the Department of Health Services is charged with developing a Medicaid DSH reduction methodology that “imposes the largest percentage reductions on the states that have the lowest percentage of uninsured individuals… [that] do not target their DSH payment on hospitals with high volumes of Medicaid inpatients, …and hospitals with high levels of uncompensated care.”

Safety-net providers are already worried that Medicaid DSH reductions may not reflect actual reductions in uncompensated care costs, and will severely impact their ability to provide services to low-income populations. Providers that serve a disproportionate number of undocumented immigrants, who are not covered by the health reform law, are particularly worried. For example, during a June 16, 2010 forum with Alan Aviles and Arthur Gianelli, sponsored by the New York State Health Foundation, it was stated that New York City’s Health and Hospitals Corporation expects to see an annual loss of $270 million as a result of reduced DSH payments.

A Way Forward

So how could the federal government best prepare for reducing Medicaid DSH funds in a way that is equitable, and doesn’t have a “disproportionately” negative effect on certain populations or states?

The most important step would be a better understanding of the current distribution and uses of DSH funds in a variety of states. This includes identifying how states define the goals and objectives of their Medicaid DSH programs, the historical uses of the funding, how Medicaid DSH funds flow to specific hospitals and health providers within states, how hospitals and health providers use these funds, the populations and communities that benefit from Medicaid DSH, and the volume and types of services financed through Medicaid DSH payments. Additionally, this requires an understanding of the interaction between the Medicaid DSH and Medicare DSH programs within states, and the processes that states use to allocate their Medicaid DSH allocations to local jurisdictions.

Understanding states’ Medicaid DSH programs has been a challenge. Even after several studies, the Government Accountability Office (GAO) has not precisely identified how and to whom DSH funds flow within states.

The upcoming reductions in Medicaid DSH funding should give states and hospitals a new motivation to provide the federal government, GAO, the public and Congress with a clearer understanding of the uses and benefits of DSH funding — before the money is gone.